CHAPTER 12 Leverage and Capital Structure 547LG1
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12 – 6 Breakeven analysis Molly Jasper and her sister, Caitlin Peters, got into the nov-
elties business almost by accident. Molly, a talented sculptor, often made little
figurines as gifts for friends. Occasionally, she and Caitlin would set up a booth
at a crafts fair and sell a few of the figurines along with jewelry that Caitlin
made. Little by little, demand for the figurines, now called Mollycaits, grew, and
the sisters began to reproduce some of the favorites in resin, using molds of the
originals. The day came when a buyer for a major department store offered them
a contract to produce 1,500 figurines of various designs for $10,000. Molly and
Caitlin realized that it was time to get down to business. To make bookkeeping
simpler, Molly had priced all of the figurines at $8.00. Variable operating costs
amounted to an average of $6.00 per unit. In order to produce the order, Molly
and Caitlin would have to rent industrial facilities for a month, which would
cost them $4,000.
a. Calculate Mollycait’s operating breakeven point.
b. Calculate Mollycait’s EBIT on the department store order.
c. If Molly renegotiates the contract at a price of $10.00, what will the
EBIT be?
d. If the store refuses to pay more than $8.00 per unit but is willing to
negotiate quantity, what quantity of figurines will result in an EBIT of
$4,000?
e. At this time, Mollycaits come in 15 different varieties. Whereas the average
variable cost per unit is $6.00, the actual cost varies from unit to unit.
What recommendation would you have for Molly and Caitlin with
regard to pricing and/or the numbers and types of units that they offer
for sale?12 – 7 EBIT sensitivity Stewart Industries sells its finished product for $9 per unit.
Its fixed operating costs are $20,000, and the variable operating cost per unit
is $5.
a. Calculate the firm’s earnings before interest and taxes (EBIT) for sales of
10,000 units.
b. Calculate the firm’s EBIT for sales of 8,000 and 12,000 units, respectively.
c. Calculate the percentage changes in sales (from the 10,000-unit base level)
and associated percentage changes in EBIT for the shifts in sales indicated
in part b.
d. On the basis of your findings in part c,comment on the sensitivity of changes
in EBIT in response to changes in sales.12 – 8 Degree of operating leverage Grey Products has fixed operating costs of
$380,000, variable operating costs of $16 per unit, and a selling price of $63.50
per unit.
a. Calculate the operating breakeven point in units.
b. Calculate the firm’s EBIT at 9,000, 10,000, and 11,000 units, respectively.
c. With 10,000 units as a base, what are the percentage changes in units sold
and EBIT as sales move from the base to the other sales levels used in
part b?
d. Use the percentages computed in part cto determine the degree of operating
leverage (DOL).